The Gold Standard: Touted by Some Presidential Candidates, Disliked by Economists

SMITH BRAIN TRUST — Several Republican presidential candidates have endorsed — or said they'd consider — putting America back on the gold standard. Sen. Ted Cruz has been the most outspoken, arguing that pegging the dollar to gold would make monetary decisions less arbitrary than the ones currently made by the Fed. Donald Trump has expressed his approval of the concept and Sen. Rand Paul has said it should be studied. Meanwhile, neurosurgeon Ben Carson has said we should "tie our currency to something," and former Arkansas Governor Mike Huckabee has suggested linking the dollar to either gold or a basket of varied commodities.

Professional economists, however, overwhelmingly reject the idea that the dollar should be tied to the price of gold. (The United States officially abandoned the gold standard in 1971, but the nation had a history of deviating from it, or bending the rules during crises, so the break arguably happened well before then.)  A survey by the University of Chicago of economists at elite universities, published in January 2012, failed to turn up a single one who embraced the gold standard. Recently, finance professor Albert "Pete" Kyle, answered questions about some issues raised by this perennial monetary-policy issue.

Q: Intuitively it sounds like a good idea to have money tied to something that's stable, that exists in the real world. Why do most economist think that is, in fact, not a good idea?

Kyle: Most economists do think it’s a good idea for money to have a target — that you should use the money supply to stabilize some index of something. The gold standard means you're stabilizing the price of gold. In the past, like the 19th century, that worked because gold was something that you could move around very easily, store in a very cheap manner, and people could kind of agree on what it was. In today's world, however, it's pretty universally agreed that what you should stabilize is the path that the Consumer Price Index follows. So the Fed targets an inflation rate of about 2 percent a year, rather than targeting a price of gold of, say, $1,000 an ounce.

There has been discussion on both sides of the political spectrum about what you should target. Conservative Republicans have proposed targeted gold, but liberal Democrats have proposed targeting nominal GDP growth. There's also a discussion, when it comes to targets for the CPI or GDP growth, as to what the actual growth rate should be. Should we be targeting an inflation rate of 2 percent a year, should we be targeting an inflation rate of 3 percent a year? Other people have proposed a commodity standard, where it might be a basket that has some gold, and crude oil, and soybeans, and wheat and things like that.

 Most people who favor that favor keeping the price at a constant, but there's nothing illogical or inconsistent about going to some kind of commodity standard that would include a gold standard that's expected to change over time. So you go to a gold standard where it starts at $1,000 an ounce and it goes up 2 percent a year. And it sort of builds a little bit of inflation into the system.

How to target a currency is an important, intellectually rich question. But most economists prefer not to have a commodity standard and not to have a gold standard.

Q: Where does interest in the gold standard come from?

Kyle: I think people in the U.S. who think about the gold standard are resurrecting thoughts from the past. But it's a little bit funny the context in which they are resurrecting them. If you go back to the 1970s, there were people in the U.S who favored going back to the gold standard because they wanted to fight inflation. They thought that having a currency that was backed with gold would somehow reduce inflation. I think what subsequently happened was that people realized that a commitment to stay on the gold standard is essentially a bunch of words, and a commitment to target an inflation rate of 2 or 3 percent a year is also a bunch of words. And it's actually easier for a central bank to honor a commitment to target 2 or 3 percent inflation than to target a gold price.

Q: So it's just that targeting inflation is logistically easier?

Kyle: Typically, if you can keep inflation at 2 or 3 percent you're not going to generate a lot of economic instability. But if you try to keep gold at $1,000 an ounce you might generate a huge amount of economic instability.

Q: Explain how pegging the currency to gold leads to instability.

Kyle: Let's suppose that people suddenly don't trust the government anymore. It might not be Americans not trusting the American government anymore. It might be people in the Middle East thinking that there's going to be war. So they pull money out of banks and they put it into gold, which they would then put under their mattresses. Under today's conditions, where you're not on a gold standard, that would just drive the price of gold up. Instead of being $1,000 an ounce, maybe it will go to $2,000 an ounce or $3,000 on ounce. But if you were on a gold standard that situation would create an acute shortage of gold, because the central banks would be obligated to sell gold to people who are demanding it at $1,000 an ounce.

The only way that could be feasible would be to make the rest of the economy consistent with a gold price of $1,000 an ounce. And that would require deflating the price of everything to the point where $1,000 an ounce is so expensive that people wouldn't want to take the gold out of the bank and stuff it under their mattresses any more. But if you actually carried that out it would create crippling recessions. That's what you saw when we were actually on the gold standard.

Q: Like when?

Kyle: After World War One, some countries, including the U.K., tried to return to the gold standard after a period of inflation. So instead of letting the price of gold go up, let's say, double, they had to halve the price of everything else in the economy. They had to engineer a 50 percent deflation of everything: wages, food prices, housing — and doing that creates a whole lot of economic chaos. And so there were very sharp, deep, extremely painful recessions associated with staying on the gold standard, which is essentially the reason it went away. When the Great Depression came along, the costs of trying to stay on the gold standard were already high on people's minds, and it would have been so costly in the Great Depression that they didn't do it. Many of the countries either went off of it or re-adjusted the price of gold.

Q: So you don't support a gold standard or tying the dollar to a commodity basket. Are there any tweaks you'd make to our current system?

Kyle: There's another kind of targeting that I have advocated a little bit in the past, and that's targeting asset prices. The Fed has said that before the financial crisis that they were targeting a combination of GDP growth and inflation, but they were not targeting asset prices. They said they were not targeting housing prices and also that they were not targeting the stock market. And what happened was housing prices and the stock market got way too high. Those prices were so inconsistent with the price of everything else that it kind of led to the financial crisis. Similarly, at the end of the 1990s, during the dot-com bubble, the level of the stock market got so high that that was also inconsistent with any pathway forward that involved any kind of economic stability. I thought that the Fed should've been targeting the stock market more in the 1990s. Seeing that it was getting too high, they should have tightened up a bit more than they did. Interest rates were high in the 1990s, but I thought they should've been made even higher, to prevent that bubble from occurring, because that bubble was very costly. The recent financial crisis was even more costly, because it involved real estate, and that could have been avoided if the Fed had targeted housing prices. I don't mean a fixed formula but a target. 

Q: Setting aside the gold standard, per se, does investing in gold offer any kind of hedge against instability?

 Kyle: If you look at the history of gold over the last 20 years it's a very volatile investment, both on the upside and the downside. Its price collapsed into the 1990s then skyrocketed prior to the financial crisis and then it came back down again. Some people might include a little bit of gold in their portfolio, but I don't think the history of gold returns suggests that you would want to put very much of your wealth in gold, because the return has historically been very low and the main reason for owning it is in a period of hyper-inflation. If you have access to gold you can protect the value of what you have.  In a starvation situation it doesn't work very well, but in the typical hyperinflation situation it can. But its returns have been so low that it's not something that I would recommend as a vehicle for saving for retirement for example. You probably should've have any more than a couple percent of your wealth in gold — and that's probably high. It's possible "zero percent" is the right number.